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Why Doesn't This Fund Fold Its Hand?

September 26, 1999

BusinessWeek Investor -- The Barker Portfolio

Why Doesn't This Fund Fold Its Hand?

Friday, Mar. 6, 1998, broke bright and crisp over Wall Street, perfect for hooky. I know because I was stuck inside an auditorium full of investment advisers. They had gathered at J.P. Morgan's formidable former headquarters across from the New York Stock Exchange to hear a famous financial scientist describe his brainchild, the Barr Rosenberg Market Neutral Fund.

In the world of quantitative investment research, Rosenberg is a titan, a pioneer in using fast computers to model--and control--financial risks. His services had been reserved mostly for big money institutions, for whom he managed $7 billion. But anyone with as little as $2,500 could get in on the new fund. Its plan: Buy hundreds of stocks and simultaneously sell short, or bet against, hundreds of others. It offered a way to invest in equities without the risk of an overall market drop. Opened the prior December, the fund's assets within months hit $314 million, as advisers rushed to get clients in.

They would have been better off playing hooky. The fund has proved an unqualified flop (chart). A $10,000 investment made on Jan. 1, 1998, was worth only $8,514 by the end of last month, according to Morningstar Inc. Had you put ten grand in a risk-free, low-yielding Treasury bill, the fund's benchmark, you would have had $10,827 by Aug. 31. A handful of rival market-neutral funds also are hurting, but none like this.

What went so wrong, so fast? To find out, I called Rosenberg's Orinda, Calif., offices. Rosenberg isn't commenting, but the fund's day-to-day manager, Will Jump, told me they're dismayed by the "awful" performance. "It's a lot more severe than we would've expected."

Just the same, the firm sees no problem with its models or computers, which scan 5,700 domestic stocks every three minutes each trading day to find those deemed cheapest and most expensive, based on such familiar ratios of value as market price to future profits and other proprietary measures. "We have not lost confidence in the strategy," Jump says. "Whenever we look at the fundamentals, we see that we're correctly building portfolios. The valuation gap between the longs and the shorts is as large as we've seen it." In other words, Jump thinks it's the market, not the model, that has gone haywire.NO SHAME. Has it? Answering that with certainty would take someone smarter than I am--or Rosenberg. But any contrarian has to be tempted into imagining that the market eventually will cycle around and begin to size up stocks the way Rosenberg's models do. Then, instead of suffering a double dose of losses, in the best of cases the fund's longs would go up, its shorts down, and investors would be doubly enriched.

That could happen. Yet I have an immodest proposal, one Jump says the firm hasn't debated: Why not close the fund, return investors' money, and just head back to the financial laboratory?

By definition, the fund doesn't try to exploit broad market moves. Those are theoretically neutralized by the mixed portfolio of longs and shorts. So there should be no shame, no "market timer" stigma, to stepping out of the market. Public mutual funds rarely liquidate, but it's not unusual among private hedge funds. In February, perplexed by the poor showing of one of its own market-neutral portfolios, rival quants at $5 billion Numeric Investors in Cambridge, Mass., did just that, giving clients back $300 million. "We clearly have more research to do," Numeric President Langdon Wheeler says.

Anxious to preserve capital, many investors in the Rosenberg fund aren't willing to wait the three to five years that Jump says may pass before the values embedded in his portfolio are realized. Already, redemptions have helped shrink the fund's assets by 63%, to $116 million. How much neater it would be for Rosenberg to take the initiative and return the rest. For a market-neutral alternative, we'll always have the T-bill.

Questions? Comments? E-mail barkerportfolio@businessweek.com or fax (407) 728-1711By Robert BarkerReturn to top